The US Dollar generated an impressive run this past week, but does the climb to four-month highs imply a robust rally through the second half of January? It is easy to be impressed by the greenback’s performance this past week. The first four-day run for the Dow Jones FXCM Dollar Index (ticker = USDollar) in two months was an impressive performance in momentum for a currency that gained ground against all of its major counterparts through the period. And yet, none of the dollar’s traditional outlets for fundamental strength were particularly supportive this past week. This past week’s performance was more of a ‘recovery’ rally. Further rally may require more encouragement.

When we see a pullback in a prevailing trend, technical traders often move to ‘buy the dip’. That same process of a temporary correction in a prevailing bearing is experienced in fundamentals. One of the most persistent fundamental dynamics behind the dollar has been the improved outlook for growth, market-based rates and yield expectations for the United Sates relative to its counterparts. We have seen these bullish/hawkish conditions mature over the past months as speculation turned into fundamental reality via data, returns and monetary policy. Yet, as persistent as the progress has been, momentum has remained under wraps as the dollar’s outperformance on these various bases remains modest. That exposed the benchmark currency to a sudden shock to the status quo.

The December nonfarm payrolls (NFPs) report released on December 10 caught the market of guard. Having grown more and more certain of a steady Taper by the Federal Reserve through 2014, the serious shortfall in net jobs growth sowed seeds of doubt. A more than 120,000-position shortfall was significant enough to undermine the hawkish implications of a 6.7 percent unemployment rate (feeding the discussion of flawed statistics and a more obstinate central bank under the new leadership of income Chairperson Janet Yellen). That uncertainty led to the biggest dollar drop in eight weeks. Fed officials made a concerted effort to offset those doubts.

This past week, a range of central bankers made a concerted effort to condition market participants to the likelihood of further hikes – and likely one on next FOMC meeting on January 29. Both voters and non-voters, hawks and doves, officials noted that fundamental conditions in growth, employment and housing were improving. A few suggested the December labor statistics were not to be over-analyzed, and were likely a one-off development. The mention of ‘costs’ related to building the balance sheet became more commonplace. And, they would all say further reductions in the Fed’s open-ended stimulus program were necessary this year.

Defusing concerns that the dollar was losing its building yield advantage was certainly fuel for a rally. But that is more the foundation of a ‘recovery rally’. Forging more extensive progress with an intensified pace requires a growing outperformance. Yet, certainty on the monetary policy front will likely remain on hold in the week before the official policy meeting – the follow up to the December Taper.

Meanwhile, the Fed’s major counterparts have seen their own monetary policy bearings improve. The threat of a new LTRO-like stimulus program from the ECB has cooled significantly after the November rate cut as data remains robust, periphery Eurozone bond yields drop to record lows and central bankers talk down the need for more accommodation. In the UK, market participants are stubbornly building up positions on expectations that the BoE will have to move forward its time frame for the first rate hike from their projected 2015 time frame. Even the BoJ stimulus upgrade is starting to lose its sway over expectations. Perhaps the Japanese central bank will reinvigorate stimulus expectations.

Relative monetary policy will be the most likely driver to set the dollar’s pace. As certainty of a January Taper sets in, the dollar will have a bullish lean; but there is little doubt in this outcome for sudden recovers. There, however, may also be the off chance of a severe risk move. If there is indeed a liquidity-threatening volatility event, expect the dollar to play the role of the preferred safe haven.

– JK

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